Widespread inflation strains US shale budgets

Surging inflation across the US shale sector is putting pressure on producers' capital expenditure (capex) budgets, just as more output is needed to counter a global supply squeeze exacerbated by the impact of sanctions on Russia.

Little in the way of respite is expected from rising costs for everything from steel to labour in coming months, shale operators warned analysts during first-quarter earnings calls over the past few weeks. With many publicly traded operators focused on improving investor returns rather than expanding drilling, these cost pressures will act as a further brake on growth. Alongside supply-chain bottlenecks, the weight of inflation will make any belated attempts to respond to the White House's repeated calls for higher production even harder to achieve, helping to keep oil prices elevated as a result.

Companies that did not already have plans in place at the start of the year to boost output — such as locking in supplies and equipment — face an uphill battle, Occidental Petroleum chief executive Vicki Hollub says. Attempting to step up activity at this late stage could jeopardise investor returns. "There has never been a time that companies have been trying as hard as they can to increase production, but we can't destroy value, and it is almost value destruction if you try to accelerate anything now," Hollub says.

Such warnings chime with a report from economists at the Dallas Fed, which flagged labour shortages and supply-chain constraints around well casing and tubing. "An industry that lacks experienced staff and materials cannot on short notice substantially increase drilling and production," wrote the report's authors, Garrett Golding and Lutz Kilian. It is hardly the case that drillers started 2022 unprepared for higher costs — with many factoring inflation of 10-15pc into annual budgets — but rather that the speed of the increase took the industry by surprise.

US bank Raymond James estimates that capex forecasts were raised by 4pc on average during the first-quarter earnings season. More than half of the firms covered by the bank have increased their capex guidance, and even more hinted that they would spend in the upper half of their planned ranges for the rest of the year. "We will not be surprised if next quarter we see another bump in capex," Raymond James analyst John Freeman says.

In the meantime, shale producers are seeking to get ahead of the curve by pursuing drilling efficiencies and locking in oil service supplies early for next year. Coterra Energy, formed in 2021 through the merger of Cabot Oil and Gas and Cimarex Energy, is increasingly relying on grid-supplied power in the Permian basin. Three-quarters of its drilling locations in the basin this year will be powered off the grid, saving an estimated $50,000/well. Pioneer Natural Resources, the biggest producer in the Permian, is drilling longer lateral wells to cut costs. The company has also started securing some services for 2023.

Shifting sands

And Devon Energy has gone one step further by starting up its own mobile sand mine, which is expected to meet up to 25pc of its proppant requirements in the Delaware basin this year. "This mine could save us up to $200,000/well, relative to the rising spot prices we are experiencing across the basin, as activity picks up and sand supply has tightened," chief operating officer Clay Gaspar says.

Despite the industry's best efforts to combat price pressures, there are tentative signs that domestic output may not rebound as quickly as expected. The EIA last week scaled back US output forecasts to 11.91mn b/d and 12.85mn b/d for this year and next, each down by 100,000 b/d from its earlier predictions. "It is going to be tough to hit some of the numbers," Pioneer chief executive Scott Sheffield says.

By Stephen Cunningham